Silver lining for commodities amid EM selloff

There’s a bit of calm in the markets today. Emerging market currencies on the whole have stopped falling, stocks are finding a bit of support and commodities are also firmer. Speculators are making a more sober assessment of the whole situation. Clearly the rout in EM currencies have been very severe and although things could go from bad to worse, you have to wonder (1) whether the markets have overreacted and (2) whether the negativity is already priced in. With yields being so high in emerging markets relative to the rest of the world, this could attract some market participants to start investing in those markets – potentially ending the currency crisis in at least some of these nations. Meanwhile speculative financial investors who have shorted emerging markets over the past several months could look to bank healthy profits on their positions. With this being such a one-sided trade, the prospects of a short squeeze rally in the likes of the Turkish Lira, Argentine Peso and South African rand could lift sentiment across the financial markets.

Copper and silver recovery could be underway

If we do see such a relief rally in EM currencies, then commodities could be among the major beneficiaries. Demand fears from China and other emerging markets have been among the main reason why metals such as copper, silver and, to a lesser degree, gold have been absolutely hammered recently. Clearly, this has been because of the US dollar’s strength, weighing heavily on emerging market currencies, including the yuan, which in turn has pushed up the costs of all dollar-denominated commodities. But demand for these commodities will never perish. At these relatively inexpensive levels, they also become attractive for long-term investors. What’s more, production levels tend to go down with lower prices, restricting supply. With reduced supply, any demand-side shock could lead to a jump in prices. So, if emerging market currencies were to regain their poise then metals could stage a sharp recovery.

Silver hits long-term support

Silver, which has been hit the hardest out of the two precious metals due to its other use as and industrial material, has actually shown some bullish price action over the past couple of days, holding its own above the key long-term support level at 14.00. However it is too early to get too excited about the prospects of a major recovery. After all, none of the key resistance levels have been tested yet, let alone broken. Short-term resistance is seen around $14.40, an old support level. In the event silver breaks through this and goes on to rise above $14.50, the most recent short-term high, then in that case the near-term outlook would turn bullish. Consequently we could see a breakout from the bearish channel and a potential rise towards the next major resistance area in the $15.18-$15.30 range.

It is also worth pointing out that the momentum indictor Relative Strength Index (RSI) is at extremely oversold levels both on the daily and weekly time frames. In fact, on the daily time frame, the RSI has created a higher lower relative to its previous low, despite silver making a lower low. In other words, the RSI has formed a bullish divergence with price, suggesting that the selling momentum may be fading. Usually, but not always, this divergence precedes a recovery in the actual underlying instrument.

A word of caution

Overall, though, these are only tentative bullish indications and so far we have not seen a clear breakdown in the market structure of lower lows and lower highs to suggest a low has been formed. But with silver at such an important level, and given the above fundamental and technical considerations, we are definitely on the lookout for a potential turnaround at or around these levels.